California public pensions are the state mechanism by which state and many local government employees in California receive retirement benefits. Two state-sponsored systems administer benefits to the state's eligible retirees: the Public Employees' Retirement System (CalPERS) and the State Teachers' Retirement System (CalSTRS). The University of California Retirement Plan (UCRP) administers retirement benefits to the university system's employees. The university Board of Regents assumes fiduciary responsibility for this plan.[4]

CalPERS oversees the following pension funds:

Public Employees' Retirement Fund (PERF)

Legislators' Retirement Fund (LRF)

Judges' Retirement Fund (JRF)

Judges' Retirement Fund II (JRF II)

According to the United States Census Bureau, the state has 57 locally-administered pension systems.[5]

A 2012 report from the Pew Center on the States noted that California's pension system was funded at 78 percent at the close of fiscal year 2010, below the 80 precent funding level experts recommend. Consequently, Pew designated the state's pension system as cause for "serious concern."[6]

The funding ratio for the state's pension system decreased from 88.78 percent in fiscal year 2006 to 77.48 percent in fiscal year 2011, a decrease of 11.3 percentage points, or 12.7 percent. Likewise, unfunded liabilities increased from just over $47 billion in fiscal year 2006 to more than $133 billion in fiscal year 2011.[7][8][9]

Features

Pension plans

In fiscal year 2012, according to the systems' Comprehensive Annual Financial Reports and Actuarial Valuation Reports, California had a total of 1,326,659 active members in its retirement plans. Our membership figures divide plan participants into two broad categories: active and other. Active members are current employees contributing to the pension system. Other members include retirees, beneficiaries and other inactive plan participants (usually terminated employees entitled to benefits but not yet receiving them).[10]

The following data was collected from the systems' Comprehensive Annual Financial Reports and Actuarial Valuation Reports, which measured fund status as of June 30 and July 1, 2011. The "percentage funded" is calculated by taking the current value of the fund and dividing by the estimated amount of total liabilities. The assumed rate of return used to calculate fund value varied by system in fiscal year 2012 (see "Rate of return" below for more information). The Government Accountability Office (GAO) and Pew Research Centers cite a percent funded ratio of 80 percent as the minimum threshold for a healthy fund, though the American Academy of Actuaries suggests that all pension systems "have a strategy in place to attain or maintain a funded status of 100 percent or greater."[11][12] The column labeled "SBS figure" refers to a market liability calculation of the fund by the nonprofit organization State Budget Solutions. This analysis uses a rate of return of 3.225 percent, which is based upon the 15-year Treasury bond yield. The organization calls this a "risk-free" rate of return that would make it easier for states to achieve their pension funding requirements in the future. Since 2006, all private sector corporate pension plans have incorporated market costs into their funding schemes.[13]

**Because the most recent valuation data available for PERF dates to June 30, 2011, and because it is by far the largest of the retirement funds discussed here, all state figures included date to 2011 to ensure proper comparability. In its calculations, State Budget Solutions used the more recent 2012 figures when available.

Annual Required Contribution

Annual Required Contributions (ARC) are calculated annually and are a sum of two different costs. The first component is the "normal cost," or what the employer owes to the system in order to support the liabilities gained in the previous year of service. The second component is an additional payment in order to make up for previous liabilities that have not yet been paid for. According to a report by the Pew Center on the States, in 2010 California paid 75 percent of its annual required contribution.[6][16]

On June 25, 2012, the Government Accounting Standards Board (GASB) approved a plan to reform the accounting rules for state and local pension funds. These revised standards were set to take effect in fiscal years 2013 and 2014.[17] As a result, ARCs were removed as a reporting requirement. Instead, plan administrators and accountants will use an actuarially determined contribution or a statutory contribution for reporting purposes.[18]

*According to the CalPERS 2012 CAFR, "LRF and JRF were funded using the Aggregate Actuarial Cost Method in prior years. The Aggregate Cost Method does not identify actuarial accrued liabilities and funded ratios. For this reason, no funding progress information is available for either the LRF or JRF prior to June 30, 2007."[7]

*According to the CalPERS 2012 CAFR, "LRF and JRF were funded using the Aggregate Actuarial Cost Method in prior years. The Aggregate Cost Method does not identify actuarial accrued liabilities and funded ratios. For this reason, no funding progress information is available for either the LRF or JRF prior to June 30, 2007."[7]

Rate of return

For CalPERS, the assumed return rate varies by fund: 7.50 percent for PERF, 5.75 percent for LRF, 4.25 percent for JRF and 7.00 percent for JRF II.[7] CalSTRS and UNCRP presume a 7.50 percent return rate on their pension investments.[8][9]

Analysis

Percent funded status of pension plansin the 50 states as of November 2013

Note: The data in this map was compiled from state CAFR reports and Actuarial Valuation documents. Figures reflect a combination of all of the state pension plans.

Funded ratio of state public pension plans as compiled by State Budget Solutions.

According to a 2012 analysis by the Pew Center for the States, most state pension plans assume an 8 percent rate of return on investments.[20] Critics assert that this assumption is unrealistic, citing changing market conditions and significantly lower investment returns across the board over the past several years.[21] When states lower the rate of return in an effort to predict investment earnings accurately, it increases the current plan liabilities, thereby lowering the percent funded ratio and causing the ARC to increase. This is because future plan liabilities are discounted based on the rate of return, so smaller expected investment returns result in larger actuarially accrued liabilities.[22] For example, on September 21, 2012, the Illinois Teachers Retirement System voted to lower its rate of return from 8.5 percent to 8.0 percent. This change increased the state's fiscal year 2014 ARC from $3.07 billion to $3.36 billion.[23] Similarly, when California's CalPERS reduced its projected annual rate of return from 7.75 percent to 7.5 percent in March 2012, it cost the state an additional $303 million for fiscal year 2013.[24]

The 2008 financial crisis had a devastating effect on pension plans nationwide and has resulted in slower economic growth and increased market volatility. In light of this, some market strategists find the 8 percent assumption to be overly ambitious. Stanford University Finance Professor Joshua Rauh stated that using past investment performance in this economic climate was "dangerously optimistic."[25] Advocates for a lower assumed rate of return argue that the standard assumptions could cause pension fund managers to engage in more risky investments and imprudent stewardship of public funds. Further, if pension plans were using more conservative assumptions, such as the 3 or 4 percent assumed rate of return used in the private sector, and the plans grew more quickly than expected, the fund would have a surplus and smaller future ARCs, which would be preferable to using optimistic assumptions and potentially being caught with larger-than-expected deficits.[26][27][28][29][30]

On the other hand, traditional public pension plan advocates argue that the dip observed in recent years is not sufficient proof of a long-term, downward trend in investment returns. According to Chris Hoene, executive director at the California Budget Project, "The problem with [the market rate] argument is there isn’t significant evidence other than the short term blip during the economic crisis that there’s been that shift. It’s a speculative argument coming out of a very deep recession."[25]

The National Association of State Retirement Administrators compiled data on the median annualized rate of return for public pensions for the 1-, 3-, 5-, 10-, 20-, and 25-year periods ending in 2013. While the median annualized rate of return failed to meet the 8 percent assumption that most public pensions assume over the 5- and 10-year periods, it was just shy (7.9 percent) over the 20-year period, and it exceeded 8 percent for the 1-, 3-, and 25-year periods. It is important to note that the NASRA data is reporting the median returns, indicating that even though median annualized returns exceeded 8 percent in the 25-year period, the investment portfolios for half of the examined public pension funds failed to meet an 8 percent assumed rate of return.[31]

In September 2013, the nonprofit organization State Budget Solutions published an analysis of state pension funding levels. In its calculations, State Budget Solutions used a 3.2 percent rate of return, the 15-year Treasury bond yield as of August 21, 2013, to discount plan liabilities.

The research found that in all states combined, state public employee pension plans have only 39 percent of the assets they need to cover their promised payments—a $4.1 trillion gap. According to the report, California's public pension plans were 42% funded, making it the 14th most funded state.[32]

Moody's report on adjusted pension liabilities

On June 27, 2013, Moody's Investor Service released its report on adjusted pension liabilities in the states. The Moody's report ranked states "based on ratios measuring the size of their adjusted net pension liabilities (ANPL) relative to several measures of economic capacity." In its calculations of net pension liabilities, Moody's employed market-determined discount rates (5.47 percent for California) instead of the state-reported assumed rates of return (7.75 percent for California's largest plan as of June 30, 2010).[33]

The report's authors found that adjusted net pension liabilities varied dramatically from state to state, from 6.8 percent (Nebraska) to 241 percent (Illinois) of governmental revenues in fiscal year 2011.[33]

The adjusted net pension liability for California in fiscal year 2011 was ranked the second highest in the nation.[33] The following table presents key state-specific findings from the Moody's report, as well as the state's national rank with respect to each indicator.

Pension fund management fees

In July 2013, the Maryland Public Policy Institute (MPPI) and the Maryland Tax Education Foundation released a report detailing the fees paid for the management of state pension systems. According to MPPI, the 10 state pension funds that paid the most in management fees relative to net assets experienced lower returns over a five-year period than the 10 state pension funds that paid the least in management fees. For example, in fiscal year 2012 South Carolina's pension system paid approximately $296.1 million in total management fees (1.31 percent of total net assets at the beginning of the fiscal year) and its five-year rate of return was 1.46 percent. By contrast, Alabama's pension system paid roughly $13.3 million in management fees (0.05 percent of total net assets) and its five-year rate of return was 7.53 percent.[34]

The table below presents the information collected by MPPI for California and surrounding states. For each state's pension system, total net assets are listed (both for the beginning and end of the fiscal year in question), as well as the total amount paid in management fees. In addition, the rates of return for the pension systems are presented. Compared to surrounding states, California had significantly higher total net assets.

Public pension fund management fees, 2011-2012

State

Fiscal year

Total net assets at the beginning of the year

Total net assets at the end of the year

Total management fees

Management fees as a percentage of total net assets at the beginning of the year

Reforms

Enacted reforms

2012

On September 12, 2012, GovernorJerry Brown signed into law significant reforms to the state's pension system. Notable changes included:[35][36]

Raising the minimum retirement age for most public workers from 50 to 52

Capping pension payouts at $132,120 per year

Requiring higher contributions from employees

Brown had initially proposed a more comprehensive pension reform package, which included the creation of a "hybrid" plan. Republican Assembly member Chris Norby said of the discrepancies between the governor's original proposal and the enacted reforms, "The governor offered us a car. This is more like a tricycle. It's never going to get us there." Democratic Assembly member James Beall Jr. said, "This is not something we're going to do overnight. We're going to have to work on this over the next several years."[35]

CalPERS estimated that the reforms would save between $42 and $55 billion over 30 years. CalSTRS projected savings over 30 years at $22.7 billion.[36] The legislation (Assembly Bill 340) easily cleared both the Assembly and the Senate.[36][37]

Events

Corruption, bribery and fraud in CalPERS top management

On July 11, 2014, former CalPERS CEO Fred Buenrostro pleaded guilty to charges of conspiracy to commit bribery and fraud. As part of a plea bargain, Buenrostro admitted in court that during his tenure as CEO of CalPERS from 2002 to 2008, he accepted approximately $200,000 in cash, delivered in paper bags and a shoebox, as well as other bribes from Alfred J. Villalobos. Buenrostro was bribed as part of a effort to win $3 billion in business managing pension money by the New York money management firm, Apollo Global Management LLC. The company claims it knew nothing of the bribe and has not been charged with any wrongdoing. According to the plea agreement, after a senior CalPERS investment official refused to provide the disclosure documents requested by Apollo, Buenrostro provided fraudulent documents, which enabled Villalobos to collect a $14 million placement agent fee. According to a 2012 report by the Securities and Exchange Commission (SEC), Villalobos collected at least $48 million in fees for his work as a so-called placement agent from 2005 to 2009.[38][39]

Villalobos, former deputy mayor of Los Angeles and former CalPERS board member, bribed Buenrostro and other pension officials in an effort to "influence billions of dollars in pension fund investment decisions" for a variety of businesses Villalobos represented. In addition to the aforementioned cash bribe, Villalobos gave Buenrostro casino chips, financed his trips, and hired him to work for his investment firm following his departure from CalPERS in 2008. A special review of placement agents issued by CalPERS in March 2011, said that the attorney general and the SEC were investigating a payment by Medco Health Solutions, which had lost the CalPERS pharmacy benefits contract, to Villalobos that “may have included improper conduct” by Buenrostro and other former board members.[40][41][42]

Buenrostro's sentencing is scheduled for January 7, 2015. He faces up to five years in prison, as well as a $250,000 fine. Buenrostro has agreed to cooperate with federal prosecutors pursuing charges against Villalobos. The case is U.S. v. Villalobos, 13-cr-00169, U.S. District Court, Northern District of California (San Francisco).[40]